News Column

Fitch Expects to Rate CITGO's Proposed Sr Secured Refinance Debt 'BB+'; Outlook Remains Negative

July 8, 2014

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has affirmed the Issuer Default Ratings (IDR) for CITGO Petroleum Corporation (CITGO) at 'BB-' and expects to assign 'BB+' ratings to the proposed new senior secured debt issuances as follows:

--$1 billion Senior Secured Bank Credit Facility due 2019;

--$650 million Senior Secured Term Loan B due 2021;

--$650 million Senior Secured Notes due 2022.

Fitch also affirms the company's pari passu, fixed-rate Industrial Revenue Bonds (IRBs) at 'BB+'. The other outstanding debt remains unaffected.

The Rating Outlook remains Negative.

Approximately $1.4 billion in balance sheet debt (excluding $255 million in capitalized leases) is affected by today's rating action.

REFINANCING TRANSACTION

The proposed CITGO transaction will result in a refinance of its existing Senior Secured Term Loan B due 2015, Term Loan C due 2017, 11.5% notes due 2017, and Revolving Credit Facility, as well as make a $300 million dividend payment to its parent using proceeds from the proposed refinancing. The security across CITGO's capital structure is expected to remain mostly pari passu and covenants will be largely unchanged from the 2010 refinancing package. The company's IRBs, which are also secured pari passu with the rest of the package, will remain outstanding.

The proposed refinancing is modestly leveraging (total debt including capital leases rises from $1.33 billion to $1.66 billion proforma) causing debt/EBITDA to rise from about 1.1x at March 31, 2014 to 1.4x proforma at year-end 2014 as calculated by Fitch. The transaction is expected to result in a modest interest coverage improvement due to lower coupons on the proposed refinanced debt, despite total leverage increasing.

CITGO has substantial headroom on a stand-alone basis at the current 'BB-' rating level. However, the company's linkage to its much weaker parent, Petroleos de Venezuela, S.A. (PDVSA) ('B'/Negative Outlook), has historically constrained CITGO's ratings.

KEY RATINGS DRIVERS

CITGO's ratings are supported by the scale and quality of the company's refining assets, with three high-complexity refineries consisting of approximately 749,000 barrels per day (bpd) of refining capacity on the Gulf Coast and Midcontinent; significant access to price-advantaged Canadian and U.S. shale crudes, resulting in strong financial performance and free cash flow (FCF); the company's export capability out of the Gulf that allows it to access higher growth markets abroad, especially distillates; and strong covenant protections in the senior indenture, which limit the ability of CITGO's parent to dilute CITGO's credit quality. Other considerations include the historical use of CITGO by its parent as a cash cow, and the historical volatility of refining.

Linkage to PDVSA

The company's stand-alone strengths are balanced by CITGO's strong operational linkage to parent PDVSA which is evidenced through CITGO's contracts to take approximately 300,000 bpd of PDVSA crude at its Gulf coast refineries, frequent appointment of PDVSA personnel to CITGO executive and board positions, and procurement services agreements between CITGO and PDVSA. At the end of March, Fitch downgraded PDVSA's IDR from 'B+' to 'B' and revised the Outlook from Stable to Negative, citing PDVSA's inextricable linkage to the government of Venezuela, which in turn has experienced heightened macroeconomic instability, delays in implementation of policies to address rising inflation, distortions in the foreign exchange (FX) market and deterioration in external accounts.

Favorable Crude Spreads

CITGO has benefited from wide discounts associated with landlocked WTI and other interior North American crudes, as embodied in the Brent-WTI gap (average of approximately $8.00/barrel year-to-date) versus historical spreads in the +/-$3/barrel range). While this spread has narrowed considerably from the $16 - $20/barrel level seen in 2011, it remains historically wide and has provided robust cash generation for refineries positioned to take advantage of it and other discounted regional crudes. CITGO can run up to 200,000 bpd of such discounted crudes in its Gulf Coast system, and approximately 100,000 bpd of Canadian heavy crudes at its 167,000 bpd Lemont, IL refinery. It is worth noting that this spread has held up despite a flood of logistics projects that have come online to move crude to consumption centers on the coasts. Current forward prices for oil suggest that a healthy discount will continue at least over the next several years.

Strong Stand-Alone Credit Metrics

CITGO's credit metrics are strong for the rating category. As calculated by Fitch, on a proforma basis, CITGO's total debt and capitalized lease obligations will be $1.66 billion versus $2.2 billion in 2009. The company's free cash flow declined to -$344.9 million as of YE 2013 but this was primarily driven by a distribution to its parent PDVSA of $887 million. Absent that distribution, FCF would have been +$542 million, given CITGO's strong cash flow from operations and relatively light capex. It is important to note in this regard that CITGO's restricted payment basket caps the company to distributing cumulative net income levels. The net income basket will be reset to April 1, 2014 upon completion of the proposed refinance transaction. Looking forward, we expect CITGO will be modestly FCF positive in our base case across the next two years.

Liquidity

CITGO's liquidity was ample as of March 31, 2014 on a proforma basis and totals $1.58 billion. This includes $130 million in cash; $1 billion in availability on its new secured revolver; and $450 million in A/R Securitization availability under the current program (the proposed refinance terms allow CITGO to issue up to $500 million). The company's new secured revolver will expire July 2019, while its A/R Securitization facility is renewed annually. In addition, CITGO has $290 million in repurchased Industrial Revenue Bonds (IRBs), which were held in Treasury and can be remarketed at the company's discretion. Additional liquidity could come from the sale of other assets, or the liquidation of excess inventory (total crude + product inventories increased to 33 million barrels as of March 31, 2014, versus more typical levels in the 27 - 28 million barrel level). Management estimates that proforma headroom on its key financial covenant will remain good with the debt-to-cap ratio expected to increase to about 45% at year-end 2014 from 32.8% at year-end 2013 (versus a 60% max). The company's interest coverage covenant will be eliminated from the covenant package given the inherent volatility in refinery results. However, the cushion is anticipated to remain solid with management's estimated proforma coverage over 12x at year-end 2014 from 15.7x at year-end 2013. The proforma maturities profile is manageable with no maturities within the next five years.

Other Liabilities

CITGO's other obligations are manageable. The deficit on the funded status of CITGO's Pension Benefit Obligation (Pension Assets - PBO) declined to -$192.7 million from -$353.5 million the year prior. The main sources of improvement stemmed from actuarial gains, and better returns on plan assets. CITGO estimates it will contribute $68 million into qualified plans in 2014. CITGO's asset retirement obligation (ARO) was essentially unchanged at $18.76 million and was primarily linked to asbestos remediation. Rental expense for operating leases rose to $170 million in 2013 and is comprised of leases for product storage, office space, marine chartered vessels, computer equipment and equipment used to store and transport feedstocks and refined products.

Covenant Protections

It is important to note that there are relatively robust covenant protections in CITGO's secured debt which restrict the ability of its parent to dilute CITGO's credit quality. These include a debt/cap maximum of 60%, with a lower 55% test for purposes of making distribution to the parent; and a restricted payment basket which limits the ability of CITGO to make distributions to its parent.

The notching between CITGO's IDR and secured ratings reflects the strength of the underlying security package, which was expanded in 2010 to include the 167,000 bpd Lemont refinery, in addition to CITGO's Lake Charles and Corpus Christi refineries, and select petroleum inventories and accounts receivables.

RATINGS SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

--Improved ratings at the parent level;

--Continued strong financial performance at CITGO centered on maintenance of low debt/EBITDA leverage ratios and continued positive FCF.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

--A downgrade at the parent level;

--A collapse in refining fundamentals or sustained operational problem at one or more refineries;

--Weakening or elimination of key covenant protections contained in the senior secured debt through refinancing or other means.

Note that this last action in particular, while not expected over the medium-term given the planned refinance transaction, would weaken the notching rationale between parent and subsidiary, as the ring fencing created by the secured debt covenants offer substantial protections to all CITGO debtholders.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014);

--'Fitch Downgrades PDVSA's IDRs to 'B'; Outlook Negative' (March 25, 2014);

--'Cash Flow Trends in the US Energy Sector (Shareholder Activism Having an Impact)' (Feb 4, 2014);

--'Scenario Analysis -- Lifting the Crude Export Ban' (Jan 27, 2014);

--'2014 Outlook North American Oil & Gas (Strong Oil Prices Continue to Support Energy Complex)' (Dec. 13, 2013);

--'Energy Handbook--Upstream Oil & Gas' (June 28, 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Cash Flow Trends in the U.S. Energy Sector (Shareholder Activism Having an Impact)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=733556

Scenario Analysis: Lifting the Crude Export Ban (Overall Credit Impact Limited but Varies by Industry)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732055

2014 Outlook: North American Oil & Gas (Strong Oil Prices Continue to Support Energy Complex)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=726499

Energy Handbook - Upstream Oil & Gas

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706481

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=838612

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

Mark C. Sadeghian, CFA

Senior Director

+1-312-368-2090

Fitch Ratings, Inc.

70 W. Madison Street

Chicago, IL 60602

or

Secondary Analyst

Dino Kritikos

Director

+1-312-368-3150

or

Committee Chairperson

Sean T. Sexton, CFA

Managing Director

+1-312-368-3130

or

Media Relations

Brian Bertsch, +1-212-908-0549

brian.bertsch@fitchratings.com


Source: Fitch Ratings


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